ERISA Stock Drop Litigation Against Financial Institutions Sheila - - PowerPoint PPT Presentation

Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; and JSM, a Hong Kong partnership, and its associated entities in Asia. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.

ERISA Stock Drop Litigation Against Financial Institutions

Sheila Finnegan, Mayer Brown LLP Reginald Goeke, Mayer Brown LLP

2

Nearly Two Dozen Sub-Prime Stock-Drop Cases Filed Over Past Year

• AIG
• Beezer Homes
• Bear Stearns
• Citibank
• Countrywide
• Fifth Third
• Freemont

General

• Hartford
• Huntington

BancShares

• IndyMac
• Lehman

Brothers

• Lincoln National
• MBIA
• Merrill Lynch
• Morgan Stanley
• Regions

Financial Corp.

• UBS
• Washington

Mutual

• Wachovia
• Wells Fargo

Defendants Include:

• Many actions related to

companies caught in sub- prime market correction

• Targets are companies

with substantial stock- drops/bankruptcies

• ERISA cases represent

perceived benefits to Plaintiff counsel (including lower pleading threshold, access to discovery, second bite at apple)

3

ERISA Stock Drop Cases: What they Are

• Action on behalf of defined contribution plans

(e.g., 401(k), ESOP)

• Based on loss to plan as a result of plan

investment in company stock What They Are

• Breach of fiduciary duty of prudence for offering

employer stock as plan option

• Breach of fiduciary duty by misleading participants into

investing in company stock (Enron)

• Breach of fiduciary duty for failing to inform

participants of material information related to company

• Other Alleged Breaches: Monitoring, Loyalty

Typical Allegations

4

Example Allegations in Subprime Stock-Drop Cases

• Plan’s Investment in Citigroup was imprudent due to

mismanagement and poor business practices, including:

• Failing to disclose liabilities from off-balance sheet SIVs
• Causing SIVs to issue debt based on misleading statements
• Extending “low documentation” loans without considering risk
• Failing to adequately disclose Citigroup’s subprime exposure
• Understating loan loss reserves

Citigroup Bear Stearns

• Plan’s Investment in Bear Stearns was imprudent because:
• Bear spent billions buying subprime loans despite increasing

delinquency rates

• Bear failed to adequately disclose subprime loan loss exposure
• Bear understated its loan loss reserves
• Bear operated without requisite internal controls

5

Typical Merits Defenses Raised In Stock-Drop Cases

Prudence Claims

• Presumption of Prudence based on 404(a)(2)
• Procedural Prudence
• Substantive Prudence

Disclosure Claims

• No Disclosure Obligation
• No Loss Caused by Alleged Disclosure violation
• Misstatements not Made in Fiduciary Capacity

Class Certification

• Individualized Issues Raised by 404(c)
• Individualized Issues Raised by Disclosure Claims

6

Use of Presumption of Prudence Depends on Three Key Issues

• Presumption based on ERISA 404(a)(2), and principal

that administrators are expected to follow terms of Plan

• Is the Plan an ESOP or EIAP
• Do the Plan provisions related to the company stock use

mandatory, suggestive or permissive language

• Twombly v. Bell Atlantic
• Edgar v. Avaya
• Whether continued adherence to Plan’s terms was

in keeping with Settlor’s expectations

• Mere stock fluctuations typically not sufficient.
• Rebutting presumption often requires a precipitous

stock decline and knowledge of impending collapse

• f company
• 3. Application of

Presumption at Motion to Dismiss

• 2. Do Facts of

case rebut Presumption

• 1. Does Plan

Support Presumption

7

Defending Merits of Prudence Claims

Factors Cases Procedural Prudence

• Due diligence with respect to

corporate transactions

• Regular consideration of

whether to offer company stock

• Seeking outside legal opinions
• Appointing independent fiduciary

Substantive Prudence

• Nelson v. IPALCO, 480 F.
• Supp. 2d 1061 (After trial

court found no imprudence even though stock declined 90%)

• DeFelice v. US Airways,

497 F.3d 410 (After trial, court found no imprudence even though company filed bankruptcy)

• Shirk v. Fifth Third

Bancorp (SJ finding presumption of prudence not overcome)

• Fiduciary need not predict future
• f company’s stock price
• Analyst recommendations
• Bond ratings
• Investments in company stock

by institutional investors

• Relative stock-price performance

compared to market or peers

• ver class period

8

Theories for Defending Disclosure Claims

Statement not made in Fiduciary Capacity

• Reliant Energy (5th Cir): Securities filings were

required to be made in corporate capacity; They were not fiduciary statements even though incorporated in S-8 and 10a Prospectus

• IPALCO (7th Cir): Plaintiffs allege that fiduciaries

should have disclosed own sales of stock.

• Court finds no duty to disclose non-material

information; Inside sales were disclosed and did not move market, therefore immaterial Disclosure Obligation Limited No Harm From Lack of Disclosure

• Avaya (3rd Cir): Plaintiff argues that adverse

information should have been disclosed earlier

• Court finds that under efficient market

hypothesis, market would have adjusted to disclosure of adverse information before Plan or participants could have sold shares

9

Potential Damages Difficult to Predict

• No court has yet found liability after a trial
• Presumption of prudence is increasingly being applied
• Likely that more cases will go to trial
• In re Delphi Corp. ERISA litigation ($47 million settlement)
• In re General Motors ERISA litigation ($37.5 million

settlement)

• Lively v. Dynegy ($17.9 million settlement)

Size of Liability Difficult to Predict Risk of Liability Improving

• Plaintiffs claim loss should be measured by “best

alternative investment.” (But see Leister v. Dovetail (7th Cir. Posner) (rejecting that measure of damage))

• Potential recovery by “holders” may depend on liability

theory Settlements can be Expensive

10

Resolution of Subprime-driven ERISA Stock-Drop Cases Will Vary by Facts of Case and Court

• Plaintiff alleged that investment in Huntington Bancshares became

imprudent when company merged with Sky Financial Group, which had a $1.5 billion subprime exposure.

• Court dismissed complaint, in part because:
• public pension plans continued to invest in Company stock.
• Hungtington’s stock price moved in tandem with its peers.
• No “red flags” that Defendants failed to see.
• Court noted unprecedented, ongoing credit crisis.
• Court noted that the courts “are currently experiencing a significant

rise in ‘stock drop cases’ due to the current status of the Stock Market and the economic climate in general.”

Huntington Bancshares

S.D. Ohio, 2:08- cv-0165 (Feb. 9, 2009)

NovaStar Financial

• Plaintiff alleged that investment in company stock were imprudent

because the company business relied on subprime mortgages for revenues, and because of improper conduct in originating those loans.

• Court denied the motion to dismiss, finding the complaint adequate

where it alleged that there was a precipitous decline in company stock price and that Defendants knew or should have known of the impending collapse of the company. W.D. Mo., 08-cv- 00490 (Feb. 11, 2009)

11

Strategies to Minimize Risk and Expense

Limit Executive Liability

• Clearly demarcate responsibilities in Plan documents,

including appointment and oversight

• Remove senior executives and board members from

committees with administrative responsibilities

• Consider using independent fiduciary

Revise Plan

• Revise plan to hard-wire company stock as option

within plan; or

• Remove company stock from plan options

Procedural Steps

• Review investment options on regular basis
• Implement regular monitoring process over

investments